Yuan Some Dollars With That?

Written by: Christopher Ploudimis

The Chinese yuan is becoming stronger and more widely accepted as a currency. Morgan Stanley predicts that in the next ten years the Chinese yuan will be the world’s third-largest reserve currency, behind the euro and the U.S. dollar. Analysts have been projecting that the yuan will account for five to ten percent of global reserves by 2030. But could it eventually overtake the dollar as the next dominant global reserve currency?

A reserve currency might mean something to someone cramming for their intro to economics exam or even more to a studied economist. But what does it really mean, and how does it impact the world around us? An international reserve currency is a currency that is held in large quantities by central banks in many different states because of its perceived stability and reliability as legal tender. In short, it is “the main currency the world uses to trade and save.” Having domination over global reserve markets projects economic influence and control over world banking and international fiscal policy. But how did the concept of modern reserve banking come about?

The Bretton Woods conference of 1944 sought to create better international financial systems and regulations at the close of World War II. Out of this conference came things like the International Monetary Fund and the World Bank. It was also here that the U.S. dollar emerged as the new international reserve currency. Per the agreement, the dollar was fixed to gold and other countries fixed their currencies to the dollar. Nowadays the U.S. is no longer on the gold standard, and other countries’ currencies are not fixed to the dollar. But the U.S. dollar remains the world’s dominant reserve currency as roughly sixty percent of foreign reserves are held in USD.

 As the dominant currency in the global economy, the dollar grants the U.S. an unprecedented amount of power in international relations. It makes sanctions against countries like Russia and Iran crippling and gives the U.S. a command over global financial markets. The Russian economy has been in a tailspin since the imposition of coordinated sanctions in response to Ukraine. Record high inflation has devalued the Russian ruble, and as of April 11th, Russia officially defaulted on its foreign debt. Iran has similarly experienced high inflation and fallen into a deep recession as a result of U.S. economic sanctions.

Recently, questions about the dollar’s supremacy have begun to arise with China at the center of the discussion. Analysts are asking whether the Chinese yuan or renminbi (RMB) could become a global reserve currency that eventually dominates the dollar. In 2010, China began promoting the yuan for use in international trade which would eventually propel it “behind the U.S. dollar, the euro, the Japanese yen, and the British pound sterling” as the “the fifth most important currency in international payments.” The IMF made the yuan an official reserve currency in 2016 when it was included in “an elite basket of currencies that comprise the institution’s Special Drawing Rights (SDR).” Growth in the use of the yuan has waned in recent years, but China’s economy is projected to overtake that of the United States by 2030. And this status as the world’s largest economy could give rise to countries holding the yuan as an increasingly important store of value in their central banks. Could the Chinese economy’s high growth lead to the yuan becoming the dominant reserve currency?

Ray Dalio of Bridgewater Associates, the world’s largest hedge fund, believes that the yuan will overtake the dollar as the dominant reserve currency. And he says this will happen sooner than expected. In his book Principles for Dealing With a Changing World Order, Dalio outlines the cycle that hegemonic empires go through and the role that currency plays in this. He claims that there are indicators of a declining empire, one of which is dominance as a global reserve currency. In his book, Dalio spends an incredible amount of time detailing China as a rising power and posits that the Chinese yuan will overtake the dollar sooner than expected. Analysts from major think tanks aren’t so sold. Eswar Prosad, a senior fellow at the Brookings Institution, says that while the yuan has potential as a major reserve currency it is “unlikely to attain safe haven status in the absence of far-reaching reforms to China’s institutional and political structures.” Indeed, without this institutional and political reform, foreign investors and governments are unlikely to store their wealth in yuan instead of dollars or euros. Institutional reform would be needed for investors to see the yuan as a safe haven, shielding them from capital flight and economic downturn.

It is difficult to say if, how, or when the Chinese yuan will overtake the dollar. But as of now, the dollar remains the dominant reserve currency, and this is unlikely to change in the next few decades. The yuan will be more widely accepted in years to come if growth is strong in China’s financial sector, but it is decades away from becoming the second or even the first largest reserve currency. With all of these questions, one thing is clear though. Having the dominant foreign reserve currency allows a state an unprecedented power. And this power can be used to influence foreign affairs and project power and wealth throughout the world.